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US Treasuries gain on June's unemployment report

US Treasury notes rose after the government said the economy lost more jobs in June than expected, increasing optimism the Federal Reserve will lower interest rates next month.

Yields on two-year notes, among those most sensitive to Fed rate changes, fell 10 basis points to 4.13 percent, the lowest since June 27 and the biggest decline in more than a month. Prices of the securities rose 1/8, or US$1.25 per US$1,000 face amount, to 99 17/32. Ten-year notes rose 7/32 to 97 9/32, lowering yields 2 basis points to 5.37 percent.

The Labor Department said employers eliminated 114,000 non-farm positions last month, compared with an expected loss of 50,000, as the unemployment rate rose to 4.5 percent from 4.4 percent in May.

"The economy remains weak, and there's risk out there that will likely keep the Fed" poised to lower interest rates, said Richard Schwartz, who manages US$65 billion in bonds at New York Life Asset Management.

Fed officials have slashed the target for federal funds, or overnight loans between banks, to 3.75 percent from 6.5 percent this year, trying to avert a recession. Today's report increased expectations for another rate cut as soon as the next scheduled Fed policy committee meeting, on Aug. 21.

In one sign of that, the gap between yields of two- and 30- year Treasuries grew 8 basis points to 1.61 percentage points, as two-year note yields fell more than bond yields. Bonds, less sensitive to rates set by the central bank, rose 2/32 to 94 29/32, reducing yields 1 basis point to 5.73 percent.

Though the payroll drop exceeded forecasts, the government increased estimates for the previous two months to show 44,000 more jobs were added to the economy, painting a mixed picture of the economy, Aubrey G. Lanston & Co analysts said.

"There's no smoking gun, as far as inflation being a problem, as far as the economy taking off," said Lanston analyst Michael McGlone, who expects a quarter-point interest-rate cut in August. "This confirms that the Fed is right on track."

The implied yield on the August fed funds futures contract, an indication of what traders expect the average overnight rate to be next month, fell 1.5 basis points to 3.695 percent.

Fully pricing in a 3.5 percent fed funds target would require a 3.67 percent contract yield. A quarter-point Fed rate cut Aug. 21 would lower the month's average about 8 basis points.

Two-year Treasury yields rose more than a third of a percentage point last week as the economy showed signs of reviving. Now, the securities will probably rally further in anticipation of the next Fed move, investors said.

"With a 3.5 percent fed funds rate, the two-year note would be very attractive," said Marc Seidner, who helps manage US$40 billion in fixed-income assets at Boston's Standish, Ayer & Wood.

Treasuries rose as US stocks slumped, suggesting some investors may have bought bonds to after selling stocks to limit their losses in the equity market.
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